Summary

Economies of scale and imperfect competition, now considered a part of the new theory of
international trade, provide a distinct departure from the traditional theory of international trade.

There is no doubt that consideration of economies of scale and imperfect competition has
broadened the scope of theoretical approaches in explaining the post-World War II development
in trade.

Consideration of economies of scale and imperfect competition in world trade helps us

understand that very similar countries (i.e. those having similar endowment holdings or
technologies) can engage in trade. It shows how a country can be both an exporter and an
importer of the same commodity.

It provides an alternative to the theory of comparative advantage as an explanation for trade. The
intra-industry trade that results from consideration of economies of scale and imperfect
competition can explain both the economic convergence and the economic divergence in the
post-war period.

1. Introduction
Traditionally, Higher Education Institutions (hereafter HEIs) have focused their efforts on
teaching and research. However, over the last two decades, above all in industrialized countries,
universities and governments alike have increased their investment in innovation and research
commercialization, fostering more effective and have been encouraging more effective linkages
between universities, governments and firms (Etzkowitz and Leydesdorff 1997 and 2000;
Etzkowitz 1998). This investment has been driven by the perceived need to smooth Technology
Transfer (TT), ensuring university innovations promote the required economic and social
development (Geiger 2004; Mowery 2007). At the same time, the motivation for HEIs to
commercialize their research has grown for a variety of reasons, including the opportunity it
affords to generate new sources of income and to strengthen links with public and private firms.

Since the early 80s, studies examining the economics of higher education have recognized the
possible presence of economies of scale in the output of the universities (Brinkman and Leslie
1986) and many papers (James 1978; Jimenez 1986; Cohn et al. 1989; Cohn and Geske 1990; de
Groot et al. 1991; Lloyd et al. 1993; Koshal and Koshal 1995 and 1999; Hashimoto and Cohn
1997; Johnes 1997; Longlong et al. 2009; among others) have analyzed both economies of scale
and of scope within HEIs, by focusing their attention on the relationship between total
university expenditure and teaching and research outputs.

Cohn et al. (1989) was one of the first studies to analyze the system of HEIs in the United States
by adopting a multi-product cost function approach. They computed economies of scale and
scope for a sample of 1,887 HEIs, covering virtually all institutions awarding four-year degrees
in America. This study was later extended by de Groot et al., (1991). First, they examined a
subsample of 147 doctorate-granting universities, from which they drew specific conclusions
regarding the economies of scale and scope for universities with a marked research
specialization. Second, they conducted a sensitivity analysis of their cost function estimates for
various measures of research output, and finally, they tested the impact of the state regulation of
personnel and financial administrative practices on production efficiency in HEIs.

In a subsequent study, Koshal and Koshal (1995) introduced the relationship between cost and
quality, stressing that earlier studies had ignored this feature when explaining the cost variations
between HEIs. They argued the importance of assuming that average university costs vary
according to the quantity and quality of their outputs. Moreover, in a later paper (Koshal and
Koshal 1999) they noted the importance of differentiating HEIs according to their specific goals,
claiming it was inappropriate to perform the same analysis for small teaching colleges and large
research-focused universities.

The main conclusions drawn from these preceding studies are the existence of ray economies of
scale, product-specific economies of scale and economies of scope in the production of teaching
and research outputs. However, the marginal cost coefficients associated with these outputs vary
significantly across the different studies.

Discussions regarding the complementarity or substitutability of research and teaching outputs

have tended to stress different features. The research findings conclude that HEIs behave as
multi-product firms, in which the presence of economies of scale and scope is relevant.
However, in recent years, the goals of universities have extended well beyond their two primary
functions of research and teaching, and gradually, TT has acquired more and more importance
for universities, governments and the private sector. However, to date, little has been said about
the presence of economies of scale and scope in the production and transmission of knowledge
in universities, when approached from the perspective of research and TT outputs.

This paper empirically analyzes the presence of economies of scale and economies of scope in
the simultaneous production of research and TT outputs in the Spanish public university system.
We employ a flexible fixed cost quadratic (FFCQ) function, relating total university R&D
expenditure and the cost of transferring technology to different outputs of research and TT.
Once the cost function is estimated, we calculate the ray economies of scale, the product
specific economies of scale and the economies of scope.

The paper is structured as follows: In section 2 we analyze the HEIs’ research and TT cost
function, describing the total cost of the production of research and the transfer of technology.
Section 3 describes the methodology used in this study. Section 4 explains the data employed,
the estimation results and the calculation of the ray economies of scale and economies of scope.
Finally, section 5 concludes.
2. Economies of Scale and Imperfect Competition

Economies of scale means gains from producing in large quantities. It is also referred to as
increasing returns. Industries use economies of scale because they become more efficient the
larger the scale at which they operate. More specifically, when there are economies of scale,
doubling of inputs to an industry will more than double the industry’s production.

Input per unit of

Level of input Level of output Average output
output
2 5 0.40 2.50
3 9 0.33 3.00
4 15 0.27 3.75
8 32 0.25 4.00
Source: P.R. Krugman and M. Obstfeld, International Economics: Theory and Policy
(New York: HarperCollins, 1991)

Table 1. Economies of scale

Table 1 shows that when inputs are increased from 4 to 8 units, output rises from 15 to 32 units
and economies of scale are realized. These economies of scale can be of two types: a) external
economies of scale and b) internal economies of scale. If the increase in the industry output is
because each firm in the industry raises its output, this is internal economies of scale. However,
if the industry output increases without each firm raising its output, this is external economies of
scale. The firm that does not increase its output level enjoys the benefit of a larger scale of
production in the industry without producing on a larger scale.

It is important to understand the distinction between these two types of economies of scale.
Under external economies of scale, a large number of firms can enter the industry to raise the
industrial output originally produced by the existing group. Each firm behaves like a perfectly
competitive firm and can thus be called a price taker. But when economies of scale are there
because the firm itself increases its scale of production (i.e. it realizes internal economies of
scale) the market structure becomes imperfectly competitive. Under an imperfectly competitive
market structure, a very large firm can behave like a monopolist or a few big firms can form an
oligopoly.

A monopolist, unlike the perfectly competitive firm, is free to set its price and output at a level
that will maximize its profit. However, unless there are barriers to entry, the monopoly profits
and incentives will be wiped out by the new entrants. Oligopolistic behavior, on the other hand,
does not provide any clear-cut rule of operations. The outcome depends on the strategies of a few
big participants in the market. It is obvious that whether we are dealing with monopolists or
oligopolies, the handling of market structure becomes much more difficult than the perfectly
competitive market behavior where price is given.
This difficulty of dealing with the market structure may explain why internal economies of scale
were not used as an explanation for trade until the 1970s, even though their importance in
analyzing economic behavior was recognized earlier. To examine the implications of imperfectly
competitive market structure with internal economies of scale for analyzing international trade,
our focus will be on monopolistic competition. Monopolistic competition consists of a few very
large firms, each of whose products are regarded as differentiated products by the consumers
(see Strategic Interaction, Trade Policy, and National Welfare).

3. Intra-Industry Trade and Love of Variety

In intra-industry trade, each country exports a set of varieties of a product and imports a different
set of varieties of the same product. Gains from trade are derived from two sources. One is the
gain from the consumption of increased variety of a product and the other is the gain in
production at a larger scale. Since each country restricts the number of varieties it produces, each
variety can be produced at a scale larger than the country could produce if it had to produce all
possible varieties.